The expansion of the Term Asset-Backed Security Loan Facility (TALF) program to include new commercial mortgage-backed securities is a step toward thawing the credit markets, experts say, but it fails to resolve the maturing $166.7 billion in CMBS that will come due over the next three years.
“This new program with new securities and new loans is fine inasmuch as it will potentially improve the liquidity situation if you’re engaging in a new deal, but it doesn’t begin to address the core problem that we face,” says Sam Chandan, chief economist for Real Estate Economics based in New York.
In anticipation of the plan, investor confidence surged in the weeks leading up to U.S. Treasury Secretary Timothy Geithner’s May 1 announcement. Indeed, spreads on AAA-rated CMBS dropped 600 to 700 basis points in advance of the news, according to Patrick Sargent, president-elect of the Commercial Mortgage Securities Association (CMSA).
What the Treasury’s new foray into fixing the liquidity issue will do is fund up to $100 billion in five-year loans to buy AAA-rated CMBS. Only securities issued after Jan. 1, 2009 that include mortgages originated on or after July 1, 2008 will be eligible for the TALF round of funding, planned for late June.
In addition to being narrow in scope, many details of the plan have yet to be ironed out. For instance, how will new CMBS issues be rated, and which of the three main rating agencies will be required to provide analysis of the new securities? Also, what commercial mortgages will be appropriate for the new issues given that the TALF loans will have maturities up to five years while typical CMBS is backed by10-year loans?
What the TALF extension is designed to help stimulate lending. “It will help banks say, ‘I see an exit strategy because I know that people will use TALF to buy AAA-rated securities’,” says Sargent, who also is an attorney and partner with law firm Andrews Kurth in Dallas.
Whether investors bite on the new TALF offering is likely to depend on the health of existing CMBS, which has shown rapid deterioration in recent months and is only expected to get worse as the year unfolds.
In the first quarter of this year, New York-based Fitch Ratings downgraded $5.9 billion of CMBS and placed another $6.8 billion on negative rating watch. In addition, the national default rate on commercial mortgages is forecast to jump from 1.6% at the end of 2008 to 3.9% by the end of this year and to 4.7% by year-end 2010, according to Real Estate Economics.
In short, there’s no guarantee to investors that the AAA bond they buy today will be a AAA bond tomorrow. “If there isn’t a material improvement in the performance of the legacy loans themselves, if we’re starting to observe widespread distress in commercial mortgage markets, then even as a potential investor for a new issue that is financing new transactions, it gives you some degree of pause,” notes Chandan.
The ratings for peak-year CMBS issuance — 2005-2007 — were also less than stellar. The largest securitized pool during that period totaled around $7 billion. Some pools were backed by hundreds of loans, though the rating agencies typically only rated the top 10 largest loans in each pool. “By any standard, the eleventh largest or the thirtieth largest were still very big loans that deserved some scrutiny,” says Chandan.
The $7 billion securitization is an extreme example. Most pools generally ranged between $1 billion and $2.5 billion, especially during the last three to four years of securitization, explains Sargent of CMSA. But in the near future, the market is unlikely to see such massive-sized loans given fundamentals and what market participants and the federal government now know about the importance of transparency.
Both Sargent and Chandan agree that future securitizations will be smaller, in the neighborhood of $1 billion and even less. Chandan believes the new securitizations won’t come from the banks but rather the conduit lenders — life companies, pension funds and investment banks — who make mortgages for the express purpose of securitization, not to hold these loans on their balance sheets.
As of mid-May, however, no new CMBS had been issued this year and the TALF funding is just around the corner. The process of originating mortgages for CMBS, aggregating them into pools and securitizing those pools as bonds has historically taken three to six months, explains Sargent.
Ryan Krauch, prinicipal of, the Los Angeles-based lender Mesa West Capital, says that his firm has traditionally made loans for value-add properties. Recently, Mesa West shifted its strategy and now focuses more on stabilized, institutional-quality assets and provides bridge loans that take borrowers to the other side of the recession.
As to whether the extension of TALF to include CMBS will ultimately help lenders like Mesa West Capital, Krauch is skeptical. “With luck it will jump-start more interest in the segment, but the federal government really needs to further vet it,” Krauch says. “Ultimately bondholders need to regain confidence in the system, and TALF won’t do that.”